Confident Qualitas Overlooked By Equity Investors

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Alternative property fund manager Qualitas has no trouble attracting investors to its property funds, providing solid growth over the past three years, yet stock market investors appear oblivious.

-Qualitas books solid first half result
-Residential cycle ready to turn
-Fund raising efforts likely ahead
-Analysts see significant share price upside

By Greg Peel

Founded in 2008 and listed on the ASX in December 2021, Qualitas ((QAL)) describes itself as one of Australia’s leading alternative real estate investment managers.

The fund manager divides its operations into four segments:

(1) Core, which focuses on inflation-hedging, resilient commercial real estate assets underpinned by strong fundamentals irrespective of market cycles;

(2) Private Credit, offering flexible financing provided to purchase, refinance and develop property;

(3) Opportunistic, involving equity investments, including joint ventures and distressed investing during market dislocation;

(4) Build-to-Rent Residential, providing perpetual capital with exposure to megatrends institutionalisation of large, resilient income streams with the growth of the sector underpinned by long-term housing supply shortage.

Late in February, Qualitas delivered a solid first half FY25 result, in line with or slightly ahead of expectations, and management reaffirmed full year guidance, representing 26-41% profit growth year on year. The first half saw record deployment of $2.4bn, up by 34% year on year, with both committed funds under management (FUM) and fee-earning FUM booking solid growth, Morgans noted.

Net funds management revenue, the highest multiple part of the business, registered 20% year on year growth, well ahead of expectations, having nearly doubled since the 2021 IPO.

Despite all of this, notes Morgans, the share price remains broadly in line with the issue price of $2.50 per share.

New Residential Cycle

Qualitas’ strong set of results reflects growth, depth and maturity of platform, Macquarie suggested, despite a relatively challenging deployment environment over the past three years. Solid capital deployment momentum, including a record half-year of $2.4bn in private credit versus $4.2bn in FY24, is laying the foundation for strong earnings growth.

Macquarie forecasts a 20% compound annual earnings growth rate between FY24 and FY27.

The start of the next residential development cycle is expected to result in a highly conducive deployment environment, Macquarie believes, as economic indicators improve in anticipation of further RBA rate cuts. Qualitas noted quality, mid-market developers are ready to commence projects, with a lot of previously shelved projects hitting economic feasibility.

At end-February, Macquarie expected momentum to accelerate following February’s RBA rate cut, with the potential for two more -25bp cuts in 2025.

Qualitas’ near-term growth agenda includes organic growth through new strategic partnerships, expanding origination and distribution reach, as well as equity opportunities, and inorganic growth through asset adjacencies and geographic expansion.

Macquarie appreciates the desire to diversify across asset classes longer term, and the need to build a broader business, but suspects any inorganic opportunities will be relatively small and Qualitas will not take its eyes off organic growth opportunities, which are plentiful.

Qualitas is considered well placed to retain its share of the growing market for private credit funded multi-unit metro residential developments, as the big four banks retreat from this type of Commercial Real Estate (CRE) lending.

From a valuation perspective, the stock has an elevated multiple, however Morgans believes that recurring organic income growth more than supports this, especially in light of management’s FY28 FUM target of $18bn, the reduced reliance on performance fees and a build-to-rent portfolio which remains a future growth driver.

Fund Raising

Early this month, the ASX-listed Qualitas Real Estate Income Fund ((QRI)) raised $218m via an offer and placement, which received strong investor support and was oversubscribed.

“Since QRI’s inception over six years ago,” noted head of income credit Mark Power, “the fund has consistently delivered on its investment objectives providing regular monthly income, portfolio diversification, and capital preservation, with no interest arrears or impairments on any loans.

“Underpinning this is our transparent and institutional approach to governance, conflicts and disciplined investment underwriting. As the market dynamics increasingly align for real estate private credit in Australia, we believe the fund is well positioned to continue to deliver attractive risk-adjusted returns for investors,” he added.

Qualitas’ “dry powder” cash balance was $1.05bn as at end-December, equivalent to some 11% of committed FUM. This represents the lowest relative level over FY22-24, Jarden notes, well below the average of around 24% over this period. Notably for Jarden, the prior lowest level of dry powder of 13% as at June 2023 was followed by the strongest half-year of fundraising, with Qualitas raising $2.04bn of capital in the first half FY24 and driving committed FUM up to $8.1bn as at December 2023 from $6.1bn in June.

Based on historical deployment levels, Jarden’s analysis suggests Qualitas could deploy $1.69-2.40bn of capital in the second half FY25 which, coupled with repayments and disposals, could result in dry powder falling further to $0.10-1.00bn, or equivalent to 1-11% of opening committed FUM.

Thus, with dry powder likely to fall well below the 24% FY22-24 average and Qualitas likely to be hesitant to have minimal capital ready for deployment, particularly as “green shoots in the Australian residential sector” are appearing, as suggested by the fund manager, with “financiers typically the first to benefit”, Jarden suspects Qualitas could pursue significant fundraising in the coming six months to rejuvenate the dry powder balance.

Jarden notes every $1bn of additional capital raised represents some $9.5m of management fees and 12-15% upside risk to consensus earnings forecasts.

Recommendations

In commenting (February 26) on the first half result, Macquarie suggested a solid result should help with market confidence. Qualitas continues to tick boxes which the market will not be able to ignore indefinitely, the broker believes, otherwise valuation starts to become even more attractive for its double-digit growth profile.

Macquarie retained an Outperform rating with a target of $3.10, up from $2.93.

As noted above, Morgans (February 28) considered Qualitas’ PE multiple to be elevated but justifiable. Adopting a blended PE multiple and sum-of-the parts valuation model, Morgans retained an Add rating, raising its target to $3.35 from $3.20.

Jarden does not see Qualitas’ PE as elevated, noting (March 11) the stock is trading at 19.7x 12-month forward earnings forecasts, implying a PE relative to the ASX200 of 1.16x, a -27% discount to the 1.47x three-year historical average.

Jarden’s valuation reflects the average of discounted cash flow expectations and PE relative to the ASX200. This leads to a retained Overweight rating, and an unchanged target of $4.00.

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